AXT Inc (AXTI) 2008 Q3 法說會逐字稿

Welcome to the AXT third quarter 2008 earnings release. Today's call is being recorded. I would now like to turn the meeting over to Dr. Phil Yin, Chairman and Chief Executive Officer.

Thank you. Welcome to AXT's third quarter 2008 conference call. I am Phil Yin, Chairman and Chief Executive Officer. I would like to thank you for taking the time to be with us. With me today is Wilson Cheung, our Chief Financial Officer. Wilson will take you through a detailed financial overview of our third quarter results and then I will give you my perspective on our markets and future opportunity. Following the conclusion of my comments, Wilson will provide forward-looking statements guidance and then we will open up the call to your questions. Wilson.

Thank you, Phil. Before we begin, I would like to remind you that during the course of this conference call, including comments made in response to your questions, we will provide projections or make other forward-looking statements regarding among other things the future financial performance of the Company and our ability to maintain profitability, control costs, and improve efficiency such as qualifying additional opportunities, our ability to continue to drive future businesses in 2009 as well as other market conditions and trends. We wish to caution you that such statements deal with future events are based upon management's current expectations and are subject to risks and uncertainties that could cause actual events or results to differ materially.

In addition to the factors that may be discussed in this call, we refer you to the Company's periodic reports filed with the Securities and Exchange Commission and available on line by link from our website for additional information on risk factors that could cause actual results to differ materially from our current expectations. This conference call will be available on our website at AXT.com through November 3, 2009. Also, before we begin, I want to note that shortly following the close of market today, we issued a press release reporting financial results for the third quarter. This press release can be accessed from the investor relations section of AXTs website at AXT.com.

Now, turning to our financial results. Revenue for the third quarter of 2008 was $17.9 million compared with $19.9 million in the second quarter of 2008. Gallium arsenide substrate revenue was $13.6 million for the third quarter of 2008, compared with $13.1 million in the second quarter of 2008. Increase in gallium arsenide revenues from prior quarter primarily came from over 1 million increased demand from several 4-inch customers offset by approximately 600,000 less demand from 2-inch and 3-inch customers while 6-inch diameter wafers sales were $5.5 million for the third quarter, same as the second quarter of 2008. Indium phosphide substrate revenue was $484,000 for the third quarter of 2008 compared with $500,000 in the second quarter of 2008.

Germanium substrate revenue was $795,000 for the third quarter of 2008 compared with $1.4 million in the second quarter of 2008. Due to the Beijing Olympics and Paralympics, sales of raw materials, primarily 99.99% pure gallium were $3 million in the third quarter of 2008 compared with $4.9 million in the second quarter of 2008. We expect sales of raw materials to increase to approximately $6.5 million in the fourth quarter as we will explain later.

In the third quarter of 2008 revenue from North America was 28%, Asia Pacific was 56% and Europe was 16% of revenue. Two greater than 10% customers generated a combined 39% of our revenue during the third quarter while the top five customers generated 62% of our third quarter revenue. As mentioned in our preannouncement on October 1, the overall market slowdown and lower than expected demand from customer orders resulted in lower production volumes coupled with a lower product mix in raw material sales, our gross margin was 25.4% of revenue for the third quarter of 2008. This included a benefit from the sale of approximately 769,000 in fully reserved wafers which positively effected the quarterly gross margin 4.3 percentage points. By comparison, gross margin in the second quarter of 2008 was 32.3%. This included a benefit from the sales of approximately 735,000 in fully reserved wafers which positively effected the second quarter gross margin by 3.7 percentage points.

Excluding stock compensation expenses, selling, general and administrative expenses were $4.8 million for the third quarter of 2008 compared with $3.5 million in the second quarter of 2008. Our SG&A expense for the third quarter included a rental forfeiture of $700,000 in connection with signing a new lease. A debt deprivation of $280,000 and bank fees of $147,000 in connection with the pay down of the $6.4 million revenue bond in early July. Now, despite the 700,000 rental forfeiture. We expect to save approximately $2.5 million in rental expense over the next seven years. Also, he excluding stock compensation expenses research and development costs were $537,000 for the third quarter of 2008, compared with $540,000 for the second quarter of 2008. Total stock compensation expense was $147,000 for the third quarter of 2008, off which $13,000 was in the cost of revenues, $109,000 in SG&A and $25,000 in R&D. Loss from operations for the third quarter of 2008 was $926,000 compared with income from operations of $2.3 million in the prior quarter.

Net interest and other income for the third quarter of 2008 was $89,000 compared with net interest and other expense of $925,000 for the second quarter of 2008. Our tax provision for the third quarter of 2008 was $177,000 compared with $635,000 for the second quarter of 2008. Net loss in the third quarter of 2008 was $1 million or $0.03 per diluted share. Note that our deposit forfeiture provision for bad debt and bank fees made up a combined $0.035 diluted EPS. By comparison in the second quarter of 2008 we reported net income of $737,000 or $0.02 per diluted share.

Let's now look at our cash in the balance sheet. Cash and cash equivalents with maturities of less than three months, short term investments and other investments in high grade debt securities with maturities of less than two years, including restricted deposits were $32.5 million at September 30, 2008, compared with $43.4 million at June 30, 2008.

As I mentioned earlier, we paid down the $6.4 million revenue bond of July 1. Accounts receivables net of reserves worth $13.3 million at September 30, 2008, compared with $13.6 million at June 30, 2008. Day sales outstanding was 68 days for the third quarter compared with 62 days in the prior quarter. Net inventory was $39.1 million at September 30, compared with $38.9 million at June 30, 2008. We expect inventory levels to begin trending down in the fourth quarter. Our cash used in operations for the third quarter was approximately $3.9 million. Depreciation and amortization in the third quarter was $527,000 and capital expenditures were $2.9 million. As of September 30, 2008, the Company including our consolidated joint ventures had 1,190 total employees. Of whom 959 worked in production. This concludes our financial review, let me turn the call back to Phil.

Thank you, Wilson. And thank you to all of our investors joining us today. The last few months have been a difficult time in our economy and in the financial markets and we are particularly sensitive to the fact that our stock along with a number of small caps have been under tremendous pressure. I think this is a great opportunity to talk about the issues we are facing. Where we are having success and where we think our industry is going.

One of the biggest challenges right now is the general market environment. With consumer spending flattening out in Q3, demand for our gallium arsenide products which go into a number of consumer, industrial, and automotive applications are softer than we have expected. As Wilson mentioned our gallium arsenide business was actually up from the prior quarter but not as much as we had originally expected it to be. Further, within our customer base, there have been some shifts in market share that impacted our business in the third quarter. However, the silver lining is that these shifts are creating new opportunities for us to penetrate accounts that have done little or no business with AXT in quite some time as they are looking for ways to handle increasing capacity requirements. In fact, the strong growth in our 4-inch gallium arsenide revenues in Q3 was a result of increased shipments to a few customers that had been represented in very small portion of our revenues in the past quarters. These customers have awarded us with their business as a result of our strong performance in quality and consistency.

In fact I am very pleased to report that according to [Fragee Analytics] newly published annual report on wafer vending ratings and customer satisfaction, AXT achieved among the highest ratings for both customer and technical parameters. We are very proud of the progress we have made and we consider this finding significant and it is the result of a survey of customers in our industry. In addition to market place challenges, we have put significant effort to resolving issues with product specification for two customers that impacted our Q3 results. For our gallium arsenide customer, our engineering team has worked closely with a customer to develop products that meets their requirements and we have expected to bring in shipments this quarter. For our germanium customer, we are completing the requalification process that is required as a result of our customer bringing up new equipment on its line. Though we expect to see germanium revenue softer again in Q4, we expect the qualification process to be completed by the year end.

The final challenge we faced in Q3 was the surprise announcement by the Chinese government to extend the transportation ban on raw materials through the duration of the Paralympics which ended September 30. While disappointing, it meant that our orders were delayed but not lost. Therefore our raw materials revenue in Q4 will be up substantially from the third quarter as Wilson has mentioned earlier.

So having said all of that, where do we go from here? Given the very tumultuous economic environment we are facing we will continue to be conservative in our planning and expectations, yet we expect to see growth in Q4 as a result of a rebound in our raw material sales and modest growth in our gallium arsenide business. Further, we remain firm in our belief that we are in a great marketplace and that the longer term growth potential continues to be exciting. This belief is underscored by our own successes in penetrating yield and unserviced accounts as well as a steady flow of new articles that highlights developing technology trends and new applications for our products. For example, earlier this months, a team of researchers from the U.S. Department of Energy's National renewable energy lab set a world record for solar cell conversion efficiencies of 40.8%. The new triple junction solar cell is a great candidate for both the state satellite market and the terrestrial concentrated photovoltaic market.

One of the most exciting parts of this news that it is grown on gallium arsenide wafers, representing a potential new market for our substrates. In addition, in a report issued earlier this month, Fragee Analytics estimates that the photovoltaic market for semiconducting gallium arsenide will grow at a compound annual average growth rate of 79% through 2012 to more than 20% of all the demand for semiconducting gallium arsenide substrates. Finally, photovoltaic applications represent only a fraction of the end markets for semiconducting substrates with LEDs driving nearly all of the usages. Another exciting announcement relating to gallium arsenide, the European Union announced in October, that it would begin a ban on all incandescent lights as of 2010. This announcement is likely to drive development efforts to LED based lighting as LED based lighting has better performance than compact fluorescent bulbs and doesn't contain Mercury.

In terms of our germanium business, we are very pleased to report that we have successfully qualified with a large European CPV solar cell company. We expect to see production volumes beginning in 2009. The application for these solar cells will be for satellites and qualification is continuing for terrestrial applications. The successful completion of this qualification is the result of more than a year of collaborative work.

Finally our raw materials business continues to be a strong competitive differentiator and a positive contributor to our financial results. This year our China joint venture which produces 4Ns gallium has further expanded this capacity reaching an annual output of 50 to 55 metric tons and thus providing AXT ample supply for our own needs and allowing us to increase our sales on the open market. So while the volatile business and financial markets have been troubling to all of us it is important to keep perspective on AXTs performance.

Our results to date, coupled with our guidance for the fourth quarter will put us at an estimated annual revenue of approximately $79 million, a 35% increase from 2007. In addition, industry trends suggest that our materials would continue to experience solid demand as they are the basis for the advanced technology road maps and communication devices, display, and general illumination and solar energy conversion. Finally, our competitive manufacturing and cost advantages coupled with our unique raw materials joint venture give us confidence in our ability to continue to achieve healthy growth. I will now turn the call over to Wilson to give you more details on the fourth quarter guidance.

Thank you, Phil. We estimate our revenue for the fourth quarter will increase to between $21.4 million and $21.9 million. Also, we stim our EPS per diluted share will be a loss of $0.01 and income of $0.02. This concludes our prepared comments. We are now happy to answer your questions.

Thank you very much, ladies and gentlemen, the question and answer session will be conducted electronically. (OPERATOR INSTRUCTIONS) We will hear first from Pierre Maccagno from Needham.

Hi, Pierre.

Your guidance, does that include or exclude options expense and also, regarding the benefit from the sale of reserve wafers exclude or excluding?

We include them in our guidance. We expect stock compensation to be in the range of between the 175,000 to 200,000. No more than 200,000. And then the fully reserved wafer sales, like in the past, we only include about $250,000 for the wafers.

Okay. Then the gallium, do you expect the gallium to increase in the second quarter?

You mean in Q4?

Yes.

If you look at our guidance, we basically are expecting between $0.5 million to $1 million more in gallium arsenide substrate revenue increases.

The decrease in the germanium during the third quarter, I guess it is not so clear. Why is it that it decreased? And what do you expect that in the fourth quarter to be?

There were two issues, Pierre. One is a spec issue. And we are basically almost resolved, the other one was the customers putting on a new reactor. So they had to tune the reactor in and get the reactor on board.

Okay, then fourth quarter we should expect some increase there?

Well, not really. Because we don't think that will get that ready in Q4. Probably in Q1 though.

So you look at our number for the Q4 guidance, we are only expecting a little over maybe around $400,000 of germanium substrate revenue for Q4.

Okay. Then your cash burn fourth quarter and next year, what do you expect that to be?

Well, as I mentioned in the script our cash use in operations was about $3.9 million for the quarter. Like I said, we spent a lot of that money. One was the pay down of the debt. And then the remaining of the money, if you just take the difference between the cash balance we also spent a lot of that cash and pay down our accounts payable. Because in the last two quarters we have been using some of that money to stockpile the inventory which we have already explained in the past. If you take that money or that item aside for paying down the debt and also, the inventory purchases, our cash burn, you know, really has note been that significant. Also, this past quarter we spent CapEx of $2.9 million for expansion. Getting ourselves ready for growth of the gallium arsenide business. Right now I would say that we have almost six months worth of inventory sitting on our balance sheet. I am not expecting much cash burn looking to the next two quarters.

So your CapEx for 2009, what do you expect that to be?

Well, we are still in the process of putting that together but I can tell you that the range for '08 we would probably end up with about 7 million or $8 million. Something like that for '08. And for '09, it would not be too far off for the number we have for '08 at this time.

I didn't get the depreciation number?

The depreciation number for the quarter is 500 -- I am sorry. Let me look. 527,000.

Okay. Thank you very much. That's it.

Thank you, Pierre.

(OPERATOR INSTRUCTIONS) We will move on to Richard Shannon from Northland Securities.

Hi, Rich.

The first question on the guidance as I was trying to run through the numbers that you gave us both on the press release as well as during the call. I was having a little difficulty getting the EPS down to the lowest levels you had. Are there going to be gross margins in the quarter that are going to be lower than expected or expenses higher or tax provisions or can you kind of help us get down from the top line down to the bottom line.

Sure. One thing I haven't pointed out to you, Rich, is even though we may have a high raw materials sale in Q4 which expect it to be about $6.5 million a big chunk of that, we will be selling actually at a lower than corporate average margins because we are targeting a specific, a particular customer that we want to penetrate. So that's one big chunk of that so you should expect margins to, might be 1 or 2 percentage points even below Q3 because we are also not expecting the capacity utilization to improve in Q4. Our capacity utilization actually has come down from the 90% plus to the low 70% range. Lastly, we are approaching year end right now. So when you look at operating expenses, we are getting to the year end audit, we are going to ramp up on a lot of the SOX and what have you, I would think that the tax provision actually would be at the same level as Q3. But if you take all those elements putting together, you should get into the range between, a loss of $0.01 to $0.02 EPS.

Okay. Specifically on the sale of raw materials at lower than usual gross margins to potentially important customers. Is that something we should expect to continue specifically with that customer?

That was a one time hit.

Okay. So, if you are selling to that customer in say, the first quarter next year, it should be at historical ranges for that product line, Phil?

Yes. That particular customer bought enough for their entire year's usage.

Got it. Okay. Great. Let's see here next question. You made an announcement about a year ago related to IQE and we know that one of their customers is not doing all that well right now and that contractor was just slated to end at the end of this year. What is the overall outlook coming from IQE? And what do you foresee in terms of happening with the renewal of that contract into next year?

Well, first of all, obviously I can't comment as far as being specific on the quantities and revenues because we have our competitors listening, one. Two, in regards to 2009, we are actually just starting discussions on their requirements. And basically, I mean, that's the only thing I can comment, I can say, that IQE is an important customer to us. They're a great customer. And but I can't really be more than that specific again to, not only to a competitor standpoint, but also due to an NDA.

Okay. Fair enough. Wilson, did I hear you say, you have two customers over 10%. Total of which is 39% for the quarter; is that correct?

Correct.

It was 62% for the top five customers?

That's correct.

Can you tell us a bit more about these one or two large customers that seem to have popped up in the third quarter?

Well, the only thing I can put a little more color for you is that beginning in 2008, we try to group all the IQE companies together as one group company. That's why you start to see that percentage grossing higher compared to last year.

Got it. Let's see. Can you give us the split of the gallium arsenide between semi insulated and semiconducting?

Sure. This quarter semi insulating is 56%. Semi conducting is 44 which is pretty much the same as last quarter. Last quarter was 57 and 43.

Okay. In terms of capacity. I know that you mentioned one and two quarters ago that you expected gallium arsenide capacity to increase by 27%. What is the status of the upgrade? Have you got any more capacity adds either in gallium arsenide or germanium or other places?

As far as the market or AXT.

AXT.

We are still continuing our expansion on the 6-inch semi insulating gallium arsenide in our China facility that is still on schedule, in fact it is still a little bit ahead of schedule and as far as germanium, we are still looking at CZ growth and looking for expansions based on the qualifications that are in place.

Okay. Maybe one final question from me and I will jump out of line. I think you mentioned that you had a bad debt provision in the quarter. Can you tell us a little bit more about what happened with that particular customer, whether that has been written down entirely, were there any accounts receivable left for the customer? And do you see more coming?

No, well, this first of all, the provision for bad debt was only based on our critical accounting policies where customers in Asia, if they have been past due for over 120 days then we just have to provide a provision for it. We haven't written it down. We are definitely keeping up with the collections and trying to get that money collected but at the same time I think given the macroeconomic environment, it is not unusual to have a couple of these customers that actually are delaying payment somewhat that we are watching very, very closely.

Okay. Great. I will jump out of line.

Thank you, Richard.

We'll move along to Jiwon Lee from Sidoti and Company.

Thank you for taking my question. Just a couple of quick ones. The gallium arsenide sales for the fourth quarter, you are guiding sequential up tick and modest up tick that could be under pressure in the December quarter. Could we get a little more color on where you expect some of the sequential strength to come back in the fourth quarter as well as short of the outlook beyond that, how should we be looking at that business in this rather challenging environment?

Well, as Wilson mentioned before, we are, our strength is coming back, some of the customers that we didn't have before. It is mainly in the 4-inch semi insulating sector. In fact, our revenue grew by over $1 million in that particular product type. So we see that area growing in the fourth quarter and going forward.

So, the expectation is mainly from the 4-inch semi insulating; correct?

Correct.

How should we be looking at this germanium business? If I understood it correctly you were guiding a little bit soft, germanium sales in the fourth quarter, but because of this new qualification effort and with this particular European customer, you are expecting a pretty nice traction next year?

That is correct. Our fourth quarter guidance is soft. Due to some spec issues and and one of our customers adding a reactor to getting that on board. Again, not only were we successful in qualifying the European customers which will start around Q1 but we have three other qualifications in Europe that are going on. I just wanted to remind you that this particular customer, it took over a year of collaborative work to qualify our product and obviously the other three, they didn't start at the same time. Right? They started at various times in the year. So we expect as those qualifications get completed, our revenues, germanium revenues will increase accordingly.

Finally, do you expect the raw materials sales to go back to where you were before, after the fourth quarter or how should we look at that business?

I do think that the normal run rate for our raw material sales would be between $3.5 million to $4.5 million a quarter.

That includes perhaps some of the pricing changes that are going on in the marketplace?

Yes, I guess. You could probably say that.

Okay. Great. I think that's all for me. Thank you.

Thanks.

We will take a follow up from Richard Shannon.

Hi, just a couple of big picture questions for you, Phil. First one is on, you talked in the past about gaining share of some of the larger wireless RFIC providers out there. Can you give us an updated status on what is going on there? Your efforts in that area.

Yes, I think one of them was a 4-inch customer. We penetrated that one that we didn't have in our customer portfolio. The other one, we are still talking with them. Discussions are continuing. That's about all I can say.

Okay. And a quick follow-up, Phil. Your stock has been trading at a substantial discount to book value for several weeks. Curious as to whether you have been approached for any sort of buyout or anything like that.

No. Not yet.

Okay. Great. Thank you.

Thanks.

(OPERATOR INSTRUCTIONS) Okay, we will move along to Peter Trapp from (inaudible).

Could you give us a little more color on how far along you are on resolving the specific product, specification issues that you have with the customers?

Yes, I think I mentioned that in my talk earlier. We are almost to the end of it, we have done many DOEs. We finally, I think honed in on the right spec. We sent them some wafers, the first batch came in very, very positive, obviously they are small quantities because they're test wafers, so the next step is to send them larger volume to see how consistent it is. So I expect sometime in Q1 that particular customer, hopefully will come back to normal volume levels.

Okay. I am assuming that it is not necessarily your fault or only partially your fault that the yields haven't been there. So do you have any recourse here or insurance against any mess ups by subcontractors?

No, not really.

Okay. So you are going to basically eat it then?

Well, when you say eating it, we are not basically eating it, it's just in the last several months we missed the volumes that they were normally at. There are no, for instance, like reject wafers and things like that.

The other thing I was going to ask you is I noticed in the balance sheet, that you didn't put out a cash flow statement I don't think, but in the notice that the long-term debt was down from 6.25 to 18,000. At the same time that the line of credit was up from 0 to 3 million, and I'm just wondering was the line of credit the partial source of money to pay off the long-term debt?

Actually, these were two totally separate transactions. On July 1, we actually paid down the entire long term debt of the $6.4 million. Then in September, we decided that we are going to draw down the credit line for $3 million. Because we don't want it to sell the investments that were sitting in short term investments because they were still holding and we want to keep that to maturity before we realize other gains, and the cost of that borrowing was only 4%. It is very low so we decided that is probably going to be the way to do it for our use of cash.

Okay. That's fair. All right. I guess that's all I have for now.

Thank you, Peter.

(OPERATOR INSTRUCTIONS) We do have one more question. This comes from [Rusty Kenton], RK Capital.

One last question on capital structure given the amount of cash you have on the balance sheet and you're selling about half your tangible book value. Any thoughts on stock buyback?

Hi, Rusty. Our Board has actually made it a priority to discuss a few times about the stock buyback option, this program. This past quarter as you are aware. Among other things we have evaluated the situation including the macroeconomic environment, we also looked at the current use of cash. Capital expenditures. And also expected working capital needs and they actually concluded at this point that a stock buyback probably is not the best solution now. But having said that, the Board to tell me and Phil to make a point that they are continuing to closely monitor the situation and it is still going to be an option on the table. So, we will continue to look into the situation.

Okay. Thank you.

At this time we have no further questions in the queue. I will turn things back to our host for any additional or closing remarks.

Thank you for participating in the conference call. During the fourth quarter we will be presenting at the American Electronics Association Classic conference and the UBS Global Technology Conference in New York as well as visiting investors in several cities around the country. We look forward to seeing you again next quarter. Thank you.

This does conclude today's call. Thank you for joining us, and have a great day.